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Microsoft’s Missed Opportunity to Take a Leap in the Tablet Market

When Microsoft announced the Surface there was a lot of expectation of the market. Since I got mine, almost every time I send an email with the signature “Sent from my Surface RT” or every time I use it in a group setting, I get asked about it – they have the market’s attention, or at least curiosity.

The device is not perfect. No device is. Even the iPad 4 has its own share of limitations and bugs. I love mine and I think it is a much more complete and usable device than the iPad. But this post is not about my opinion aout the device, which you can read here on Quora. My observation is that every Surface user I have heard from has generally the same reaction: “Compared to the Surface, the iPad is a toy.” or “Since I got my Surface, my iPad is in a drawer”. The point is not to say the device is better – every customer has to make that decision on its own. The point is that Microsoft has a real fighting chance.

The device launched just in time for the Holiday season. It still did OK, in my opinion, selling a million units in its launch month against 14 million units sold by Apple. Yet the opporuntity was much larger. The problem (or a problem) is that a 32Gb iPad costs exactly the same, $499. This forces buyers to make a concious decision of buying the Surface versus the iPad. Here is the opportunity:

What would have happened it Microsoft had launched the Surface at a price of $275?

There would be no comparison against an iPad at $499. It would make the competitive decision much easier for customers who were not already sold on iPad. A large chunk of the market made of people who don’t want to spend $499 for a tablet wuld probably jump in. It would be a no-brainer compared to a 16Gb iPad mini at $329.

At $275. the Surface would certainly be a better buy than the Kindle HD, which sells for $299, and was selling at a rate of a million units per week at the peak of the holiday season.

The economics make sense

The cost to manufacture a Surface RT with 32Gb of memory, according to iSupply, is $271. Let’s assume Microsoft sells 5 million Surfaces instead of one million, just for the sake of the conversation. If we take $224. of profit from each of these four million units, that would have decreased $896 million in profits for Microsoft.But in reality it only sold a million, so te actual los in profits would only be $224 million.

That would have taken its operating income from $7.77 billion for Q3 2012 to ‘only’ $7.55 billion. hardly a dent, and well above the $6.6B from the same quarter last year. More importantly, it would have added $1.1 billion in extra revenue to bring the quarter from $21.46B to $22.56B, avoiding a miss of expectations (see stock price for the impact of that).

My point: reducing the price of the Surface to $275. would have had virtually no impact to profits and would have had a large impact on revenue. Microsoft could have opted to make this a promotional, limited-time offer, creating a sense of urgency for consumers.

Even at the $275. price, Microsoft would have a profit opportunity in the lucrative accesories market. An installed base of millions of devices creates a large opporutnity to sell keyboards, cases, mice, applications and other accesories. they could have charged a nominal monthly fee for Office.

Microsoft’s opportunity to earn a solid footing in the post-PC era is surely worth more than a 3.5% decrease in profits.

Besides the neglible impact to profits, the only other downside I can think of is the impact to OEM partners. This is an important point, but one on which Microsoft should have decided on when they decided to enter the hardware business. Would Acer and Dell be upset our would they have been thankful for the creation of a market, acceleration of the application base and pressure to be more competitive?. Yet, the upside for Microsoft could be very big:

$1.1 Billion in increased revenue for the quarter, bringing revenue not only in line with expectations, but probably exceeding it.

Creating a product line with $4 Billion in revenue, esentially overnigt would be an incredible business success by any measure.

The stock is near the bottom of its 52 month range at $27.55 as I write this. I can’ speculate the actual impact to the stock price, but I think it is reasonably to expect a jump if microsoft had sold 5 million Surfaces. Every dollar increase in stock price creates $8.3 billion in stockhohlder value. The stock has hovered around $30 for a decade despite very large increases in sale and profits. You could argue an event like this could generate positive momentum.

Microsoft would have earned significant economies of scale, bringng the costs down for them and OEM partners, providing a long-term economic advantage.

It would have eliminated any doubts of the consumer adoption of Windows 8 which would have lifted the entire ecosytem incluidng sales of Windows Phone and PCs, resulting in a benefit to OEM and accelerated porting of applciations to Windows 8. Maybe we would have Instagram on Win 8 by now.

Apple would have sold less iPads. Let’s assume out of the 4 million incremental units two come from would-be Apple buyers. Microsoft is a very competitive company, this would not be an insignificant win.

Imagine the impact of the news “Apple sells only 12 million iPads in Q4, Microsoft sells 5 million in its first quarter”. The brand, PR, employee morale and talent acquisition value of this statement is woth much more then a 3.5% decrease in profits. Imagine the Businesweek cover story “Microsoft is Back”.

When Microsoft priced the Surface at $499 I was very suprised, knowing Steve Ballmer is hyper competitive and a long-term thinker that has demonstrated a discipline to invest in markets for the long term. Microsoft has a lot of smart people, I am sure they spent considerable energy in their pricing startegy.

I believe the Surface will be successful anyway. The 128Gb Pro model sold out in hours. A million units in their first quarter is not bad, even compared to the iPad’s 3.3 million in its first quarter. But I can’t avoid thinking of what could have happened with a more agressive pricing strategy. We probably would be in an alternative future. your thoughts?

For the record, I admire Steve Jobs and Apple and have blogged about it a couple times.

Disclosure: I worked for Microsoft from 2004 to 2008, I am no longer affiliated with the company but still own some stock. As with all post in this blog, this post reflects my personal opinion. I own a Dell PC, a Surface, a Lumia 920 and a Zune. We have an iPhone, multiple iPods and an iPad at home. I have used Macs since the 1980s and sold a few of them when I was in the digital imaging business.

When Microsoft announced the Surface there was a lot of expectation of the market. Since I got mine, almost every time I send an email with the signature “Sent from my Surface RT” or every time I use it in a group setting, I get asked about it – they have the market’s attention, or at least curiosity.

The device is not perfect. No device is. Even the iPad 4 has its own share of limitations and bugs. I love mine and I think it is a much more complete and usable device than the iPad. But this post is not about my opinion aout the device, which you can read here on Quora. My observation is that every Surface user I have heard from has generally the same reaction: “Compared to the Surface, the iPad is a toy.” or “Since I got my Surface, my iPad is in a drawer”. The point is not to say the device is better – every customer has to make that decision on its own. The point is that Microsoft has a real fighting chance.

The device launched just in time for the Holiday season. It still did OK, in my opinion, selling a million units in its launch month against 14 million units sold by Apple. Yet the opporuntity was much larger. The problem (or a problem) is that a 32Gb iPad costs exactly the same, $499. This forces buyers to make a concious decision of buying the Surface versus the iPad. Here is the opportunity:

What would have happened it Microsoft had launched the Surface at a price of $275?

There would be no comparison against an iPad at $499. It would make the competitive decision much easier for customers who were not already sold on iPad. A large chunk of the market made of people who don’t want to spend $499 for a tablet wuld probably jump in. It would be a no-brainer compared to a 16Gb iPad mini at $329.

At $275. the Surface would certainly be a better buy than the Kindle HD, which sells for $299, and was selling at a rate of a million units per week at the peak of the holiday season.

The economics make sense

The cost to manufacture a Surface RT with 32Gb of memory, according to iSupply, is $271. Let’s assume Microsoft sells 5 million Surfaces instead of one million, just for the sake of the conversation. If we take $224. of profit from each of these four million units, that would have decreased $896 million in profits for Microsoft.But in reality it only sold a million, so te actual los in profits would only be $224 million.

That would have taken its operating income from $7.77 billion for Q3 2012 to ‘only’ $7.55 billion. hardly a dent, and well above the $6.6B from the same quarter last year. More importantly, it would have added $1.1 billion in extra revenue to bring the quarter from $21.46B to $22.56B, avoiding a miss of expectations (see stock price for the impact of that).

My point: reducing the price of the Surface to $275. would have had virtually no impact to profits and would have had a large impact on revenue. Microsoft could have opted to make this a promotional, limited-time offer, creating a sense of urgency for consumers.

Even at the $275. price, Microsoft would have a profit opportunity in the lucrative accesories market. An installed base of millions of devices creates a large opporutnity to sell keyboards, cases, mice, applications and other accesories. they could have charged a nominal monthly fee for Office.

Microsoft’s opportunity to earn a solid footing in the post-PC era is surely worth more than a 3.5% decrease in profits.

Besides the neglible impact to profits, the only other downside I can think of is the impact to OEM partners. This is an important point, but one on which Microsoft should have decided on when they decided to enter the hardware business. Would Acer and Dell be upset our would they have been thankful for the creation of a market, acceleration of the application base and pressure to be more competitive?. Yet, the upside for Microsoft could be very big:

$1.1 Billion in increased revenue for the quarter, bringing revenue not only in line with expectations, but probably exceeding it.

Creating a product line with $4 Billion in revenue, esentially overnigt would be an incredible business success by any measure.

The stock is near the bottom of its 52 month range at $27.55 as I write this. I can’ speculate the actual impact to the stock price, but I think it is reasonably to expect a jump if microsoft had sold 5 million Surfaces. Every dollar increase in stock price creates $8.3 billion in stockhohlder value. The stock has hovered around $30 for a decade despite very large increases in sale and profits. You could argue an event like this could generate positive momentum.

Microsoft would have earned significant economies of scale, bringng the costs down for them and OEM partners, providing a long-term economic advantage.

It would have eliminated any doubts of the consumer adoption of Windows 8 which would have lifted the entire ecosytem incluidng sales of Windows Phone and PCs, resulting in a benefit to OEM and accelerated porting of applciations to Windows 8. Maybe we would have Instagram on Win 8 by now.

Apple would have sold less iPads. Let’s assume out of the 4 million incremental units two come from would-be Apple buyers. Microsoft is a very competitive company, this would not be an insignificant win.

Imagine the impact of the news “Apple sells only 12 million iPads in Q4, Microsoft sells 5 million in its first quarter”. The brand, PR, employee morale and talent acquisition value of this statement is woth much more then a 3.5% decrease in profits. Imagine the Businesweek cover story “Microsoft is Back”.

When Microsoft priced the Surface at $499 I was very suprised, knowing Steve Ballmer is hyper competitive and a long-term thinker that has demonstrated a discipline to invest in markets for the long term. Microsoft has a lot of smart people, I am sure they spent considerable energy in their pricing startegy.

I believe the Surface will be successful anyway. The 128Gb Pro model sold out in hours. A million units in their first quarter is not bad, even compared to the iPad’s 3.3 million in its first quarter. But I can’t avoid thinking of what could have happened with a more agressive pricing strategy. We probably would be in an alternative future. your thoughts?

For the record, I admire Steve Jobs and Apple and have blogged about it a couple times.

Disclosure: I worked for Microsoft from 2004 to 2008, I am no longer affiliated with the company but still own some stock. As with all post in this blog, this post reflects my personal opinion. I own a Dell PC, a Surface, a Lumia 920 and a Zune. We have an iPhone, multiple iPods and an iPad at home. I have used Macs since the 1980s and sold a few of them when I was in the digital imaging business.

3 Comments on “Microsoft’s Missed Opportunity to Take a Leap in the Tablet Market”

Christopher Wicke

Your $271 number is purely physical materials as the article states. An added estimated $13 of manufacturing costs and then an unknown licensing and software costs, not to mention advertising added in tell me that $275 would clearly be a loss position for MS. Assuming they don’t want to take a loss, want to make some money per unit, I would suggest that a starting price of $349 would still be a significant enough discount to earn a huge uptick in sales.

Your numbers are wrong on the price of an iPad. At $499 you get a 16GB iPad, it’s $599 for the 32GB, so the Surface RT is actually at a lower price point already.

I don’t know what they were thinking, but at launch, you could only get the 64GB version for $699 with their touch cover. This seemed a big misstep as well. I don’t know if you have the manufacturing costs on the touch cover and type cover, but I think these should have been either a part of the package or more significantly discounted as well.

I agree that Microsoft made some significant mistakes in their launch, and the only reason I can see was to keep their OEM partners as happy as possible.

Mr. Ballmer promised to give every employee a Surface. It makes them happy. High price will make them much happier. Don’t worry about the technology, customers or even market, as long as Microsoft employee are motivated and full of proud again, them can do amazing things. Because Mr. Ballmer believes in People Ready Business.